Passive Income ???

An owner is selling his business.  He will be paid in equal annual installments over the next 10 years, well over 6 figures each year.  He will not be working for the new owners and will likely be retired.

Would the income he receives from the sale over the next 10 years be considered passive income?  He is asking whether he can set up a solo 401k for himself, create a sole prop business entity for himself and use the annual payment to him as a basis for funding a solo 401k plan.  Is proceeds from a business sale considered passive income and prohibit him from using it for retirement plan purposes?

Thank you

if it walks like a duck, quacks like a duck, smells like a duck, its probably a duck. 

That being said - there aren't enough details to know. 

The real question isn't "Are proceeds from the sale passive income?" 

It's "Will he(as an individual) have earned income at a sufficient level to make it worth starting a 401(k) plan?"

The money he receives for the business sale - where is it being paid? to an LLC? to him personally? Etc?

If it is actually going to an LLC or entity - what is going to be his personal earned income from that entity? Zero? 

For example - if he has a LLC with an S-Corp election, but no W-2, then he has no earned income. 

If he only receives a K-1 Form 1120S, then no earned income. 

If its a 1065 K-1, is there earned income reported on it? 

His CPA will need to tell you if he actually has earned income. 

It depends. Will any of the income be paid as earned income reported on a  Schedule C and subject to SE taxes or will he maintain a corporation that will pay him a W-2 salary out of the incoming payments? Or will it all be recovery of basis and long term capital gains in the business?

Probably need to talk to his accountant. if he's not going to have any Earned income or W-2 wages, then the answer is probably a hard no. If it's being paid as a "consulting fee" that he'll get a 1099-MISC and run it through a Schedule C or his corporation, it's probably yes.

This is an accounting and tax planning question first and foremost (including whether the proceeds are capital gains) after which the retirement plan question could be answered.

Earned income for retirement plan purposes must be for personal services performed.  The sale of a business would generally be capital gains.

Thanks everyone.  Great replies and information.

Generally, sale should’ve been structured as an asset sale and an ongoing consulting contract for transition, support and non compete. The asset sale is capital gain , the consulting would be self employed income.